The danger of after hours trading

After hours trading Netflix

Some months ago I there was a little event that reminded me about some issue that affects those who swing trade stocks.

That event was a significant after hours gap in the trading of Netflix due to some unfortunate news about its subscription statistics.

It was a 25% gap from the previous close. So, you can imagine the panic for some people who was long the day before that. It could be even worse if those people were leveraged, which is quite usual in CFDs trading.

In my case I noticed it because I had a sell stop order if the price fell below $424. The order was opened at the day opening price. I was not interested in opening a trade like that so I got out immediately.

I was, somewhat bearish in that stock, but did not expect that the bear market was going to start with a 25% gap. And, despite thinking that the stock would be heading south anyhow I did not want to keep on that trade. But, never mind, there are more stocks and there will be more trades.

Netflix gap

Gap after hours trading

One of the greatest dangers that investors face in the Stock Market is without a doubt, having open positions when the markets are closed.

I have to recognize that it was one of my main worries when I started trading years ago. It was one of the reasons that convinced me that doing day trading was the answer.

How could I leave a trade open the whole night or the weekends? I was scared of that.

Brokers are the main promoters of day trading and one of the tactics they use is to remind of the dangerous trading after hours.

In some way that is true, trading after hours is very dangerous.

Cases like that of Netflix occur every day because there are thousands of stocks in the markets. But, there are ways to reduce risk, like not being too leveraged, and diversifying your trades.

For instance, trying to trade several stocks at the same time, with just a little leverage for each one (if a stock unexpectedly falls 20% I lose 5%, for example).

After hours trading leverage

For those without experience the advice is using as little leverage as possible, preferably nothing. Also, novice traders should trade very liquid and stable markets. Markets whereas big gaps like that are not likely to occur.

The biggest problem with gaps and after hours trading is with stocks trading.

The world of CFDs is particularly affected by this due to the fact of the big leverage involved.

For instance, Netflix is quite a popular stock. I am sure that some people were leveraged two or four to one in this stock the day before. Some people could easily see their accounts wiped out by this event.

Icelland stock market collapse

Other example that comes to mind is that of Iceland stock market in 2008, when their Government decided to close it for several days due to the violence of the financial crisis.

When the market opened some days later, it was 77% below the closing price. However, the guy who was trading the long side leveraged, would be completely bankrupt and owing money.

So, we can see how the government can screw things up unnecessarily. If the market has to fall, it will fall irrespectively of what the government does. And, I think that it is likely that a similar event may happen in some other European country some day in the near future.

In those crazy days of 2008, even some very liquid markets like DAX or CAC had significant after-hours moves.

Like I said before, one solution to this problem is to adapt a policy of diversification.

After hours trading Forex and CFDs

Imagine you trade stocks CFDs, and our swing trading strategy involves holding stocks for weeks or even months. The best way to do that is by not investing all in the same stock, but in a different “portfolio” of stocks. Doing that, we decrease the chance of being severely hit by a big gap move.

If we trade ten stocks and use a 3% stop loss, I should not assign more than 0.5% of my account to any individual stock. So if one stock falls 3% I lose 0.5% of my account, and if it falls 30%, I lose 5%.

Anyhow, we should be very careful when trading assets with leverage, with or without after-hours trading.

In fact, we should also be careful even when we are not leveraged.

There is no easy path in the world of trading. Every path is full of traps. Even that of long-term investing.

 

Thanks for reading and sharing.